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Japanese Stocks and Yen

It seems that recently we are having a media focus on the relationship between the Yen and the health of the Japanese stock market. Clearly in time of market volatility it is usual practice for analysts and alike to attempt to detect relationships and stick some explanatory variables on it. Someone has to make a living I guess…The current media contention is that the strength the Japanese Yen somehow explains the recent demises of the Japanese stock market. Clearly there may be some degree of truth in this as a stronger Yen would somehow dent the commercial margin of exporters and therefore some degree of correlation should be expected between domestic stock value and Yen (depending on the hedging approach of the underlying companies). That being said, a strong yen would also reduce the cost of importing goods and energy for Japan so overall the effect may be not as pronounced as one would expect. The below chart shows both the evolution of the Yen and the Nikkei since 1996 and the rolling correlation over a 125-day rolling window of daily returns. There has been a strong increase in the correlation but it still remains below the statistical threshold of significance….. What we observed is also somehow atypical of the whole period where the correlation remained muted and oscillating at levels close to Zero.

Rolling 125-day correlation between daily returns of the Nikkei and USD-JPY exchange rate.

Clearly the correlation test focuses on the similarities of the series deviations from their own means, so it does not tell us the story. If the Yen affects the margin of exporters/importers and subsequently the perceived valuation of their stocks, one would expect a causal relationship to be present. So it is clearly time to go quantitative on this. In the following we look at the 125-day rolling P-values of a Granger causality test .

125-day rolling P-value of Granger Causality test.

Looking at the above results the causal relationship has been instable. True, as of recent time the value of the Yen seems to drive (cause) the relationship but there has been periods in the past where the Yen has been significantly strong/weak and this had no effect on the way the causality works. In summary though there may be a bit of truth in a possible relationship it is clearly a weak one. To predict the Nikkei I would rather focus on other factors such as Domestic/Foreign appetite for Japanese assets in period of renewed economic growth…..